Industrial property a hot commodity in 2018

The once-humble industrial shed looks set to be one of the most sought after asset classes by real estate investors in 2018 as the growth in e-commerce drives up demand for modern logistics facilities.

Prime industrial property in Western Sydney, where zoned land is scarce and rents are rising, will be particularly sought after, as will new, modern facilities and development sites in the best industrial precincts of Melbourne and Brisbane.

"2018 will see continued strong demand from customers for good quality locations," says Greg Goodman, chief executive of Australia's biggest and most successful industrial developer, owner and manager, Goodman Group.

New logistics facilities are being sought around the world. Pat Scala

"There's a real tailwind of demand for industrial from customers as ongoing drive for efficiency and the rise of e-commerce forces companies to look at their supply chains and industrial warehouse footprint," Mr Goodman told The Australian Financial Review.

"Customers are looking for locations close to consumers and this will continue to drive demand in markets along the eastern seaboard, particularly in infill locations in Sydney and down the major motorways."

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Goodman Group, whose No.1 customer is online retail giant Amazon, was one of the best performing real estate investment trusts (A-REITS) in 2017 riding the crest of the e-commerce and online retailing wave.

Others like Frasers Property Australia, Macquarie-backed LOGOS, Dexus and Mirvac are also riding the same wave, funnelling capital into new logistics projects and striking leasing deals with major retail brands, logistics groups and wholesale distributors for new distribution centres and logistics hubs.

"Investors around the world are still under-invested in property, including industrial property, and there are plenty of mandates to purchase," says BIS Oxford Economics analyst Christian Schilling and author of its latest report on the Sydney industrial market.

"[In Sydney] investor demand is so strong that there are 20 potential buyers for every property that comes on to the market," Mr Schilling says.

When the final numbers come in for 2017 more than $US100 billion ($128 billion) is likely to be invested in prime logistics assets around the world, after commercial real estate agents CBRE put the value of deals in the first three quarters of the year at $US85.8 billion.

"Prime logistics is an attractive asset class for investors that provides a high return and stable cash flow due to the strong user fundamentals, which is largely fuelled by e-commerce growth and demand for last-mile logistics," says Jack Fraker, managing director, global industrial and logistics, CBRE.

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"Given the amount of institutional capital in the global market, and the robust appetite for logistics real estate, strong investment activity should continue in 2018 with some markets experiencing further yield compression."

Australia is particularly attractive market for international investors given the much higher yields relative to other global first world markets.

Despite yields tightening about 190 basis points over the last five years, Sydney still offers a prime yield of 5.8 per cent compared with 3.75 per cent in Hong Kong and 4 per cent in London, CBRE figures show.

The problem for investors in Australia has been both a scarcity of prime assets to purchase and a shortage of suitable land on which to develop new assets, especially in Sydney.

According to JLL, industrial property investment volumes are actually expected to fall for the first time in nine years in 2017 once the final numbers come in.

"This is due to the limited stock placed for sale rather than lack of investor appetite," says Michael Fenton, JLL's Australian head of industrial.

"Transactions occurring through the year have recorded comparatively sharp yields. Despite this, we anticipate investment volumes will still exceed long-term averages with a handful of large transactions expected to close in the final quarter of the year."

The shortage of development-ready industrial land combined with strong demand has led to the rapid appreciation in land values themselves and will continue to drive up rents in Sydney and Melbourne, according to Mr Fenton.

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BIS Oxford Economics expect prime Sydney industrial rents to rise 15 to 20 per cent over the next four to five years, primarily as a consequence of yields rising 100 basis points.

These softer yields will squeeze development margins initially, but eventually, he says, developers will have no choice but to raise asking rents. "If not, construction will become unprofitable and they will stop building."

"If tenants are averse to paying higher rents and delay leasing decisions, developers will stop building. There will be a delay, but it will only be a matter of time until vacancies fall to levels that deliver the rental growth required to kick-start development.

There's unlikely to be any development delay in Sydney, if suitable land is available, given the current land constraints and strong demand.

"In 2018 competition for well-located land will continue. As a result, we should see a growing trend towards conversion of brownfield sites to new modern logistics facilities in these supply constrained markets," says Greg Goodman.

"Long-term holders will be looking to unlock the value of the land and redeveloping existing holdings may be a more viable option than acquiring at current pricing. There will also be greater intensification of existing facilities as customers implement smarter technological solutions.

"The challenge to supply is that industrial sites remain some of the most flexible real estate with industrial property adapting to 'higher uses' such as data centres, office or residential. This should lead to consistently high occupancy levels, low vacancy rates and positive rental growth for prime properties."